Just as the banking industry charges interest for their loans, there is no reason for any factoring business not to do the same. After all, how else can they make a profit? Factoring companies will provide you with the cash you need to meet payroll or pay equipment fees, but they also expect to be compensated for their services. They’re not in it just out of the goodness of their hearts.
So how do AR factoring companies determine how much they will charge you? Each company has its own ways of charging you, but in general the fees will depend on the following factors:
- Value of account receivables. While the more invoices you involve in the factoring process will help lower the cost of the factoring, the most important is the value of each invoice. Having just ten invoices factored will cost you less if each one is worth $100,000. Having a thousand invoices worth a thousand each will cost you a lot more. That’s because the factor invests time and manpower for each invoice given to them so dealing with one large invoice is a lot more cost-efficient for them than working on a hundred small invoices.
Of course, the most ideal scenario is if you have lots of accounts receivables and each one is worth a lot of money.
- The state of the industry. From the point of view of a factoring company, not all industries offer the same level of risk. Some industries are notoriously difficult for a small business to survive. The restaurant business is a good example. Medical clinics, clothing stores, and construction firms are also considered high risk. With these industries, factors usually charge a higher rate, and the advance they offer on the value of the invoices are usually lower than average.
- Types of customers. The factoring company will also take note of the kind of clients and customers you have. The factoring company prefers to deal with companies who engage in B2B (business to business) transactions rather than B2C (business to customer). Businesses are more streamlined in their payments, and they usually have enough funds to pay what they owe.
On the other hand, individuals are more erratic. Also, they tend to deal with lower volumes and values, which as what we’ve already mentioned, are not agreeable with factoring companies.
- Customer credit. Factors take a very close look at the credit history of your clients. They check to see if they pay their debts in full and on time. They also check on the stability of these customers, because obviously, if they’re on the brink of bankruptcy they won’t be very attractive to factoring companies.
Here your best bet is to have customers with an established credit history, and who have a stellar reputation when it comes to paying their debts. With a roster of such reputable companies, factors will probably be inclined to charge you less in interest and fees. That’s because there’s a low probability that the factor won’t be able to recoup the money they advanced to you.